The Economy & You #31: Evaluating Economic Policy

A graph of the Early 1980s recession in the United States. Blue line is Percent Change From Preceding Period in Real Gross Domestic Product (annualized; seasonally adjusted) Red line is Average GDP growth 1947–2009 Data is from the Bureau of Economic Analysis. (Photo credit: Wikipedia)

In a previous article I spoke of the concept of normative economics that analyzes the outcomes of economic behavior and evaluates whether the outcomes are good or bad. Determining whether an economic policy is good or bad requires that criteria be applied in the analysis of the policy. The four most common criteria used to evaluate economic outcomes are efficiency, equity, growth, and stability. In this article, I will provide a simple summary of each criterion and how they are often applied to economic policy evaluation.Efficiency

In economic terms, efficiency refers to allocation of resources. An efficient economy is one that produces what people want at the lowest cost. An economic system is said to be more efficient (relative to other systems) if it can provide more goods and services without using more resources. In absolute terms, an economic decision is considered economically efficient if:

• No one can be made better off without making someone else worse off.

• No additional output can be produced without increasing the amount of inputs.

• Goods and services are produced at the lowest possible per-unit cost.

These definitions listed above are not exactly the same. Still, they all embrace the idea that an economic decision is efficient if nothing more can be produced with the resources available.

While there are many ways inefficiencies can occur people disagree how the economic distortions are caused and what is the solution. Some argue that distortions are caused by government through laws and regulations. The way to minimize these distortions is to reduce government influence and involvement. Advocates of laissez faire economics argue that such policies protect property rights and therefore are just, regardless of whether or not they are more efficient. The dominant belief is that market economies are generally more efficient and government involvement is only required through fiscal policy and monetary policy to address distortions.

The counterargument is that economic fluctuations are caused by the markets themselves and the way to address such inefficiencies is for government to be involved. Economic efficiency occurs when there are no imperfections in the market. In addition, efficiency is the notion of optimality and does not necessarily result in a socially desirable distribution of resources because it takes no position about equality or the overall well-being of a society. Opponents of laissez faire argue that these policies lead to a concentration of power and thus limit liberty and reduce competition which then leads to an unjust distribution of income and wealth.

Often, efficiency is contrasted with morality, usually fairness or justice. Some economic policies may be seen as increasing efficiency, but at the cost to fairness or justice. It is the classic laissez-faire versus neoliberalism argument. The question being argued is to what degree (if any) the government should be involved in economic decisions.

Equity

While efficiency can be applied with some degree of precision, equity or economic equality is another matter. Many believe that equity means an equal distribution of income or wealth. Fairness could therefore imply addressing the issue of poverty. The idea of economic justice and to what extent government should subsidize the poor through economic assistance continues to be a topic of discussion among political leaders.

Equity is based on the philosophy of equality. Equity examines at the distribution of capital, goods and access to services throughout an economy and is often measured using tools such as the Lorenz curve and Gini index. Government plays a central role in the redistribution needed for equity between all citizens, but applying this in practice is highly complex and involves difficult choices. Should we promote equal opportunity or equal results?

Growth

Economic growth is an increase in the total output of the economy often measured as the percent rate of increase in real gross domestic product, or real GDP. Growth is calculated in real terms in order to address the effect of inflation on the prices of the goods and services produced. If output rises faster than population growth, then output per person (or per capita) rises and the standard of living increases.

It’s assumed as the economy grows; it will produce more of what people want. Government policies can be put in place to encourage or discourage economic growth. Governments pass laws designed to encourage growth in specific industry sectors in many ways. Research and development are often subsidized through tax credits or exemptions. Infrastructure expenditures are also seen as promoting economic growth. On the other hand, some argue that tax laws which deter wealthy individuals and businesses from domestic business investment or incentivize investing their resources in other countries will cause growth in the U.S. to decline.

Stability

Economic stability refers to an absence of excessive fluctuations in the economy. Eeconomic stability is the condition where national output is growing steadily with low inflation and full employment. An economy with fairly constant output growth and low and stable inflation would be considered economically stable. An economy with frequent large recessions, very high or variable inflation, or frequent financial crises would be considered economically unstable.